The Advisors' Blog

– Chan Pedris, ISS Corporate Services

Plans featuring fungible or flexible ratios continue to gain ground. Fungible plans often add flexibility to the way a company can deliver its equity awards; these plans employ a “fungible ratio” that, in many cases, makes shareholders indifferent between a company granting appreciation awards, such as options or SARs, and full-value awards.

A fungible ratio provides that appreciation awards will deplete the equity plan’s share reserve by one share for each appreciation award issued, and that full value awards will deplete the share reserve by some greater number. That number is generally tied to the relative value of appreciation and full value awards at time of grant; using this ratio, at the time of grant, shareholders should be indifferent whether the company grants appreciation awards or full value awards.

Fungible plan adoption rates vary by size of company, but they are rising among companies across all market indices. In 2013, 44.2 percent of S&P 500 companies proposing an equity plan adopted fungible share plans vs. 29.3 percent of small cap companies that make up the S&P 600 index. Even among the smallest companies, nearly one in five equity plan proposals contained fungible features.

Companies across all indices are becoming more sophisticated in the way that they employ equity compensation. Firms today have a much richer broad based equity strategy that encompasses their Short term/Long term compensation plan design needs, inducement and retention grants, and the overall metrics around percentage of employees eligible to receive grants. And, they have increased their appetite for flexibility in granting full value versus appreciation awards from the same pool – and for delivering those awards efficiently.

On the other hand, many companies have sound rationale for choosing to adopt a more conventional monolithic or limit-based plan. In numerous cases, the costs associated with fungible plan administration are higher, and there is more complexity involved in maintaining a plan – and these factors can be especially material for smaller companies. However, technology has significantly lowered the cost and administrative burden associated with managing and tracking award types, making fungible plan designs accessible to more and more firms.

Some of the non-adopters consciously continue to practice liberal share recycling. Under this provision, which is generally frowned upon by institutional investors, shares tendered from option exercise or for tax withholding can replenish the plan reserve in perpetuity. The benefit of such a provision is that companies receive more utilization for their shares – using option proceeds to repurchase shares to increase the plan reserve has the effect of increasing the share reserve continuously. Proxy advisory firms generally require plans with fungible designs to prohibit liberal share recycling provisions or be faced with the prospect of a higher award valuation.

We expect the adoption rates of fungible plans to continue to rise.